Because I was distracted today (houseguest, plus preparing for out of town trip), I haven’t spent as much time as I would have like on the Congressional hearings into the Bear bailout.
Judging from the media reports, it seems that the assertive presentations by the perps, um participants in the deal were not met with aggressive questioning by the assembled Congressmen. But the lack of sparks flying does not necessarily mean that they were persuaded. Supreme Court watchers warn that the demeanor of the Justices is seldom a reliable guide to how the court will rule. That observation may apply here.
Nevertheless, there were some priceless moments in self-delusion and dissembling artful presentation. :
First is Bear CEO Alan Schwartz saying in retrospect that there was nothing he would or could have done differently; Bear had “adequate capital and liquidity.” The facts prove conclusively otherwise. Reading between the lines of the later testimony, that JPM and the Fed hint at a solvency problem (and not merely because Bear was on the verge of filing for bankruptcy). Schwartz came out of the investment banking side. He is highly unlikely to have been able to judge the quality of Bear’s riskier positions.
This is also a man who did not do well under pressure. Not only did his manifest discomfort during an investor presentation help seal the bond trading firm’s fate, but he mis-heard the deal that he got on Thursday from the Fed via JPM. It was an overnight loan so they could get into the weekend, while he thought it was for 28 days.
Taking Schwartz at face value, there was no real reason for Bear to collapse other than gossip. Merrill and Citigroup’s efforts to shore up confidence and their ability to meet obligations with capital infusions will not protect them. Bear, despite its failed hedge funds, quarterly losses and ousted chief executive, was in fantastic shape. “Adequate capital,” remember?
Except that there wasn’t. “There was a failure to understand the gravity of the problem,” according to Christopher Dodd, D-Conn., the committee chairman.
Second is the SEC soft-shoe, a bookend to Schwartz’s “everything was fine, really, it was those evil shorts.” According to the SEC, Bear did have adequate capital, that is, regulatory capital. When I started out on Wall Street, in the day of stone tablets and abacuses, even junior dweebs understood that SEC capital requirements were not often the consideration that dictated how much the firm was geared. And as debt instruments have become more complex and derivatives have skyrocketed, the SEC has remained primarily concerned with equity markets. So I’d expect regulatory capital requirements to be a binding constraint even less often than in the past.
In the New York Times, Floyd Norris pillories the SEC for its insistence that a failed metric is adequate. The SEC’s logic reminds me of LTCM chief John Meriwether’s stance after his fund failed. He continued to maintain that his models were fine. The problem was reality.
From Norris:
Bear Stearns never ran short of capital. It just could not meet its obligations…. “At all times,” wrote Christopher Cox, the S.E.C. chairman, in the aftermath of the collapse, “the firm had a capital cushion well above what is required to meet supervisory standards.”….Does it sound a little like a doctor emerging from a funeral to proclaim that he did an excellent job of treating the late patient?
“That kind of statement is a condemnation of the kind of supervision that the S.E.C. did,” said one expert on financial regulation, Edward J. Kane, a finance professor at Boston College, in an interview this week. “If there is good capital, you should be able to convince your counterparties of it.”
The S.E.C. assumed that Bear, or any other investment bank, could always borrow against securities it owned. It assumed that lenders would put up at least 93 percent of the value of those securities, and as much as 97 percent for the safer ones.
In a working paper for the National Bureau of Economic Analysis, prepared for a conference to be held next week at Cambridge University, Mr. Kane assigned some of the blame for the current credit crisis to international regulatory competition, in which national regulators, fearful of seeing business go overseas, dared not be too tough.
Instead, regulators from around the world agreed on common capital standards, the latest version of which is known as Basel II. That standard has loopholes that allowed banks to add lots of leverage, some of it pushed off balance sheets in ways that obscured the risks that remained and minimized the apparent need for capital. …
“A severely overleveraged banking system may be portrayed as an accident waiting to happen,” Mr. Kane wrote. “A regulation-induced crisis occurs when misfortune impacts a banking system whose managers have made their institutions vulnerable to this amount and type of bad luck.”
For now, market revulsion is limiting leverage in the system and driving banks to raise more capital if they can. Mr. Cox told a Senate hearing Thursday that the Basel committee should think more about liquidity. But there has been no admission from regulators that they erred in letting leverage get so far out of hand that a “well capitalized” company could not find anyone willing to lend it money without government help.
Third is “the assets the Fed took are fine.” Steve Waldman, who took the trouble to read and parse an attachment to Timothy Geither’s presentation that set forth the terms and conditions for the operation of the LLC that will hold these positions., focuses on the disclosure that some of these assets included related hedges, which are derivatives. More important, Waldman concludes that the Fed isn’t on the hook for just $29 billion but could wind up stumping up more:
It’s official. The LLC that the Fed and J.P. Morgan recently formed to manage $30B Bear Stearns assets has taken over a portfolio of derivative positions along with those assets. Those positions involve both rights to receive and obligations to pay whose value may depend upon both circumstance and counterparty quality. Of course, if liabilities associated with those positions ever exceed the value of the LLCs assets, the limited liablity company could declare bankruptcy, so in theory, the Fed’s maximum exposure is $29B. But, if, out of reputational concern or to promote systemic stability, the Fed would inject capital rather than let the LLC default, then the Fed has indeed become a counterparty of last resort.
Looking simply at the behavior of the main actors, Michael Shedlock concludes these instruments can’t be all that hot. From Shedlock:
This is galling. Everyone is praising the quality of the assets offered to the Fed as collateral, but JPMorgan would not take them outright. Why not? And while the Fed is on the hook for fallout from those assets, what about the other assets JPMorgan picked up for next to nothing? What are those worth? Was JPMorgan acting like a “responsible corporate citizen” or a vulture financing corporation?
Fourth was Geithner’s presentation. Geithner is generally very well regarded, yet I have come to the view that as head of the New York Fed, he was in a position to have seen what was going awry, yet remained blind alternative courses of action.
He gave a very long speech, parts of which seemed designed to run out the clock so as to reduce the time available for questions (does the panel really need a discussion of the history of the Fed?). Read this section, which came at the beginning:
This was a period of rapid financial innovation—particularly in credit risk transfer instruments such as credit derivatives and securitized and structured products. There was considerable growth in leverage, greater reliance on ratings on structured credit products and a marked deterioration in underwriting standards.
The innovation in financial products was accompanied by a dramatic increase in the amount of financial intermediation occurring outside the core banking system. The importance of securities broker-dealers, hedge funds, and mutual funds in the financial system rose steadily. Off-balance-sheet vehicles of various forms proliferated, and increased concentrations of longer-dated assets were held in funding vehicles with substantial liquidity risk.
In a speech he gave a bit more than a year ago, Geithner covered much the same ground (without the road kill details we now have) framed more positively, and pointed out that only 15% of the non-farm credit extension was via banks. We noted at the time:
Geithner has no objective foundation for his rosy view. He has essentially admitted the Fed and other regulators lack a complete, or even good, picture of what is happening. We’ve had money supply growth well in excess of GDP growth, and loose monetary conditions can obscure underlying weaknesses. His argument boils down to,”Our current structure and distribution of risks is outside the bounds of anything in financial history. We can muster some arguments as to why this should be OK, and so far, it has been OK.” I don’t find that terribly convincing.
And in that speech, he in effect said it was OK for regulators to supervise only in the most minimal way:
We cannot turn back the clock on innovation or reverse the increase in complexity around risk management. We do not have the capacity to monitor or control concentrations of leverage or risk outside the banking system. We cannot identify the likely sources of future stress to the system, and act preemptively to diffuse them.The most productive focus of policy attention has to be on improving the shock absorbers in the core of the financial system, in terms of capital and liquidity relative to risk and the robustness of the infrastructure.
These issues are the principal focus of day-to-day supervision and market oversight in the major financial centers around the world. The Federal Reserve is actively involved in a range of efforts, working closely with the primary supervisors of the major global financial institutions and the critical parts of the financial infrastructure, to encourage further progress. In this context, we are working to put in place a stronger regulatory capital regime and to strengthen the capacity of firms to absorb losses in stress conditions. We are encouraging more sophisticated and more conservative management of credit exposures in over-the-counter derivatives and structured financial products, as well as of exposures to hedge funds. And we are encouraging a range of efforts to modernize the operational infrastructure that underpins the over-the-counter derivatives markets, and to improve the capacity of market participants to manage a major default.
How can you “encourage” behavior changes among parties you don’t regulate? Where you don’t have enough of a view of what they are doing to even suggest where they might need to trim their sails?
Yet today, the Fed’s and Treasury’s message to Congress was: we withstood this test, the system works, butt out.
They should consider the warning of General Phyrrus: “One more such victory, and we are lost.”
14 comments
I am glad that at the hearings the congress did not push claims from some like John Hussman that Bear Stearns’ counterparties would not have taken a haircut in bankruptcy. That is flat wrong. When Mirant went bankrupt, counterparties in its energy trades took a haircut for market movements prior to Mirant’s bankruptcy filing. Bear Stearns’ counterparties would have faced the same, as pointed out at morningstar: http://socialize.morningstar.com/NewSocialize/forums/post/2503492.aspx
Please note that Cox pointed out that Bear’s liquid asset position declined from $ 10 billion to $ 2 billion in a single day (Thursday I believe). This lends more credence to the claim that the change in Bear’s actual liquidity position was abrupt enough to completely change the interpretation of its risk overnight.
The presentations were more interesting than charade in my view. I think there are two core issues:
1. Some sort of continuity of regulatory risk standards between bank depository institutions and investment banks – most importantly capital and liquidity guidelines. The Fed’s new discount window expansion is the point of no return toward this objective now.
2. The failure of commoditized quantitative risk models. This enabled a historic easing of effective capital requirements across the system and the enabling of increasing leverage, including the dilution of macro capital underpinning of risk, with the widespread use of off balance sheet quantitative capital arbitrage.
The regulatory community should tackle these strategic issues before responding with a structural proposal.
The willful efforts of the Fed, the SEC, the Treasury to absolve themselves of any and all accountability is nothing short of stunningly damning.
Dodd could have had their heads. He should have had their heads but chose not to at a time when heads were needed. Yesterday’s testimonial farce further damaged the credibility of, and confidence in US capital markets.
I’m still trying to understand what happened to Bear in the repo market. As Geithner pointed out (btw he read an abbreviated version of the speech at the hearings), nobody predicted that fully collateralized borrowing markets would dry up.
Why would any lender refuse to lend overnight against Treasuries? I can understand demanding a steeper haircut because asset values are less stable than they used to be, but I can’t understand not lending. Does anybody actually understand what happened here?
My take on this was that The Fed and Treasury (nice Paulson didn’t have to speak) usurped authority from Congress, but this hearing swept that matter under the rug as fast as possible in suggesting this action saved the world from vast economic destruction, which essentially is related to Paulson’s $700 million bank account. The issue from Schwartz, was somewhat correct in that he thought The Fed should have opened up an emergency lending facility, like the discount window, which would have allowed for a somewhat normal exchange,versus this extortion-like blackmail attempt under duress to negotiate this abusive antitrust “acquisition” before the stock market opened in Japan monday morning — where I assume Paulson, et al were going to take a BIG loss. Obviously, those nasty shorts were going to try to cash in on fraudulant accounting and mismanaged derivative accounts and manipulated markets, etc…
The other issue is that Bear and JPM are not “banks” and thus that changed everything for this charade, thus here is some background on that:
Deal on Bank Bill Was Helped Along By Midnight Talks
http://query.nytimes.com/gst/ful…ul…8260&sec=& spon=
At 2 o’clock on Friday morning, a few scant hours after his pessimistic report to the President, Mr. Dodd and other exhausted Democratic lawmakers placed a telephone call to a weary Treasury Secretary Lawrence H. Summers to report that they had clinched a deal with Mr. Gramm to repeal the Glass-Steagall Act of 1933. After eluding its advocates for decades, the agreement to deregulate Wall Street, favored by many of the nation’s most powerful business interests, was struck.
The meeting in the middle of the night was the final chapter in a saga that began in 1934, when Senator Carter Glass himself tried to undo the law that put his name into the history books. The meeting capped a month of posturing, brinkmanship and dealmaking in Washington. And its outcome is expected to bring about one of the most important changes in decades in the laws governing the nation’s financial system.
I know this is too long here, but the following are several outtakes posted yesterday on calculatedrisk, but it offers some history tips and questions the terms of this “loan” and why The Fed is in the business of lending money and using The Treasury as a conduit for an un-authorized and unprecedented bailout!
>> As background, The Chrysler Corporation Loan Guarantee Act of 1979 was signed into law January 7, 1980, and established a loan guarantee board with the authority to issue up to $1.5 billion in government loan guarantees for the Chrysler Corp., a failing company, over the next three years.
A number of strings were attached to the bill. To receive the loan guarantees, Chrysler was required to:
“Win concessions from the companys workers, plus $500 million in new
credit from U.S. banks; $125 million in new loans from foreign banks and
other creditors; $250 million in aid from state and local governments;
$180 million in aid or credit from dealers and suppliers.
· Sell off $350 million of company assets or other equity ….etc…
>> Moving forward to Bear Hearing, but back to The Great Depression:
President Franklin Roosevelt signed a bill into law that added Section 13(b) to the Federal Reserve Act, which authorized the Federal Reserve to “make credit available for the purpose of supplying working capital to established industrial and commercial businesses,” according to the Federal Reserve Board’s 1934 annual report.
In the depths of the Depression, the country’s relatively nascent central bank, arguably still struggling to find its role in the U.S. economy, was being asked to get into the lending business, and much to the chagrin of one Rep. C.L. Beedy:
The Federal Reserve banks, 12 in number, which were never designed to do business with any individual or any person, but were banks of issue or rediscount to deal with other banks, ought never, in my opinion, to be put into the lending business. It is a perversion of the original purpose for which those banks were established.
Hence, The Fed is permitted to make IPC (individual, partnership, and corporation) loans directly to the private sector, but only under stringent criteria. This latter power has not been used since the Great Depression but could be invoked in an emergency.
Furthermore, Unlike some central banks, and barring changes to current law, the Fed is relatively restricted in its ability to buy private securities directly. However, the Fed does have broad powers to lend to the private sector indirectly via banks, through the discount window.
Therefore a second policy option, complementary to operating in the markets for Treasury and agency debt, would be for the Fed to offer fixed-term loans to banks at low or zero interest, with a wide range of private assets (including, among others, corporate bonds, commercial paper, bank loans, and mortgages) deemed eligible as collateral.
12. The Fed is allowed to buy certain short-term private instruments, such as bankers’ acceptances, that are not much used today. It is also permitted to make IPC (individual, partnership, and corporation) loans directly to the private sector, but only under stringent criteria. This latter power has not been used since the Great Depression but could be invoked in an emergency deemed sufficiently serious by the Board of Governors. Return to text
13. Effective January 9, 2003, the discount window will be restructured into a so-called Lombard facility, from which well-capitalized banks will be able to borrow freely above the federal funds rate.
14. By statute, the Fed has considerable leeway to determine what assets to accept as collateral.
However, in terms of the ability of taxpayers to be involved in this process:
The New York Fed presented a one-page description of the portfolio. The assets include investment-grade securities and residential and commercial mortgage loans, all of which were current on principal and interest as of March 14. The staff of some lawmakers will be able to review the full list on a confidential basis, the statement said.
Federal Open Market Committee Transcripts
http://www.federalreserve.gov/fo…mc/Transcripts/
In all the transcripts, a very small amount of information received on a confidential basis from, or about, foreign officials, businesses, and persons that are identified or identifiable was subject to deletion. All deleted passages, indicated by gaps in the text, are exempt from disclosure under applicable provisions of the Freedom of Information Act.
This one point still stands out for me:
Effective January 9, 2003, the discount window will be restructured into a so-called Lombard facility, from which well-capitalized banks will be able to borrow freely above the federal funds rate.
Thus, what about the issue of Bear being well-capitalized? I guess the way they got around that reality was to call this an acquisition….. however, the FTC did not sign off on this and the way in which this was rushed through should void this collusive corruption due to a lack of DD!
bitch, bitch, bitch:
Remarks by Governor Laurence H. Meyer
Before the Spring 1998 Banking and Finance Lecture, Widener University, Chester, Pennsylvania
April 16, 1998
http://www.federalreserve.gov/Boarddocs/Speeches/1998/199804162.htm
… Nevertheless, deregulation has been a major force for change in the banking and financial services industries. Two decades ago we still had Regulation Q, the Glass-Steagall Act was widely viewed as requiring a virtual prohibition of combinations of commercial and investment banking, and interstate banking and branching were barely fantasies even at the state level, let alone applications for combinations of insurance and banking. Just a few days ago, the House of Representatives almost voted on a massive re-write of the laws on permissible bank holding company activities and is now scheduled to consider the issue early next month. It is difficult to predict the outcome of that bill, and I will not. But I will note that the pressures of market developments for changes in the rules set up during the Great Depression are immense. If Congress does not act, loopholes and regulatory changes will continue to be exploited — with or without bank participation. The forces of technology and globalization will deregulate in one way or another. I and my colleagues would prefer that the Congress would guide those changes in the public interest, but legislative deadlock will not do the job because the status quo will not hold.
However, in some cases we still observe potential competitive problems with a proposed bank merger. Fortunately, the antitrust laws, as written into the banking statutes, give us the means to maintain competition in such situations. These laws require that the Board approve only those mergers that are not expected to substantially harm competition. When implementing this policy, the Board may require changes to a merger proposal, and may even deny an application, if the merger or acquisition would result in a highly concentrated market, or an excessively large increase in concentration. As I indicated a few minutes ago, the focus of our analysis is normally on local retail markets for banking products and services.
A panel of whores making small talk with their johns and the limo drivers.
What I don’t understand is Geithner’s response to why the Fed didn’t act sooner to the crisis by opening up the discount window to IB’s like Bear. His response was:
“I would not have been comfortable lending to Bear at that time,” he said. “We only lend to sound institutions. Lending freely to Bear would not have been a prudent act.”
Does that even make sense? I thought the discount window was indeed setup for banks that needed it, and that banks ended up _not_ using it because of the stigma attached to its use? Wasn’t that the whole reason that the auction facility was setup in the first place?
“in which national regulators, fearful of seeing business go overseas, dared not be too tough.”
What happened to our free trade policy ! Maybe the free traders were right about government intervention to protect a particular industry.
It would seem that a summary of the governments response and action plan is equally applicable to the US prison population.
“Hey, if you drop the soap, just leave it.”
anon 4:26
…that goes back to Bear not being well-capitalized before or after and so they all agreed to the last second extortion deal of a forced illegal acquisition, which like magic made Bear whole.
The real question related to the capitalization of JPM and how sound it was — without the payoff/loan from The Fed! Which also related to a lack of DD or review for antitrust violations. That deal should be voided!
See also: (as a term of jurisprudence) is a possible legal defense, one of four of the most important justification defenses[1], by which defendants argue that they should not be held liable because the actions that broke the law were only performed out of an immediate fear of injury. Black’s Law Dictionary (6th ed.) defines duress as “any unlawful threat or coercion used… to induce another to act [or not act] in a manner [they] otherwise would not [or would].” The notion of duress must be distinguished both from undue influence in the civil law and from necessity which might be described as a form of duress by force of circumstances
Henry (4:22),
Regarding Geithner’s response:
“I would not have been comfortable lending to Bear at that time,” he said. “We only lend to sound institutions. Lending freely to Bear would not have been a prudent act.”
That’s funny because I thought Ben Bernanke and Chris Cox (at SEC) both stated on the record that Bear Stearns was “adequately capitalized”. If that was the case, then Bear Stearns was a “sound” institution, which diametrically contradicts what Geithner just said.
Sounds like total BS, and presumably nobody in Congress called him on it. They just swallowed it whole.
Way back many years ago, people would get in trouble for lies, false and misleading information and other bullshit — like at the hearing yesterday:
Perjury is the act of lying or making verifiably false statements on a material matter under oath or affirmation in a court of law or in any of various sworn statements in writing. Perjury is a crime because the witness has sworn to tell the truth and, for the credibility of the court, witness testimony must be relied on as being truthful. Perjury is considered a serious offense as it can be used to usurp the power of the courts, resulting in miscarriages of justice. In the United States, for example, the general perjury statute under Federal law provides for a prison sentence of up to five years, and is found at 18 U.S.C. § 1621. See also 28 U.S.C. § 1746.
The rules for perjury also apply to witnesses who have affirmed they are telling the truth. Affirmation is used by a witness who is unable to swear to tell the truth. For example, in the United Kingdom a witness may swear on the Bible or other holy book. If a witness has no religious beliefs, or does not wish to swear on a holy book, the witness may make an affirmation he or she is telling the truth instead.
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Hello all,
Imho, a key to getting taxpayers a good payoff for bailing out speculators is showing Big Media how it can profit obscenely by fighting gratuitous moral hazard.
Toward this end, please consider signing my online petition for The Learning and Earning Modernization, Moral Hazard Minimization and Entertainment Programming Talent Full Employment Act of 2008.
The URL: